Thursday, September 18, 2008

Let’s Discuss Various Types of Business Debt

score_tjpg_bour This article was written by Norm Bour, SCORE Orange County Management Counselor

Cash flow is the lifeblood of any business, no different than the blood that keeps us alive. Without positive cash flow your business dies. It is one of those things that most business owners take for granted, grumble about and try to control. Yet they rarely sit down and analyze it and develop an orchestrated plan to eliminate it.

We’ve categorized debts into four major groups: mortgage debt, equipment debt, inventory and revolving or personal debt.

Mortgage debt is usually, but not always, the largest debt for a business. If you own a building it is typically the “best” type of debt since it is long term and more stable than others. Our goal is to eliminate all the other debts that impede cash flow so we can focus everything towards that mortgage debt.

Equipment debt is one that some businesses do not have, but if you are involved in manufacturing or any type of production these costs can be high. Doctors, dentists and medical related fields typically have significant equipment debt. Many times these loans are in the forms of leases, which make a lot of sense for many reasons. Lower payments and the ability to phase out obsolete equipment or technology are just a few.

Inventory debt can be considerable in many cases. We did a case study of a motorcycle dealership with $400,000 in parts inventory, some of which had not turned over in more than one year. In addition they also paid “flooring” on $600,000 worth of motorcycle inventory which ran another $20,000 per month. When we were done with the analysis we recommended almost 20% less inventory of new stock and liquidating tens of thousands of dollars in parts that were not moving. After paring both these items down we were able to increase the cash flow by $5,000 per month.

Revolving debt is probably one of the necessary evils of most businesses, and allows money available as a reserve or for emergencies. As is obvious you want to pay these types of debts off quickly since they are usually expensive with a variable rate. They can be secured or unsecured lines and are fairly easy to get as long as you have credit.

Taking a good look at all these expenses and calculating the damage from all and the collective positive cash flow is the first step in analyzing your business. We have been teaching mortgage acceleration strategies since 2002 and when those same techniques are applied towards business debt the pay off period can be incredibly fast.

If any one of areas is out of line and if the cash flow is negative it is critical that you repair that as soon as possible or you will hemorrhage yourself out of business. If you are fortunate enough to have positive cash flow, then it’s smart business to work on acceleration of all those debts and get rid of them as quickly as you can.

Editor’s note- Norm has a radio show dedicated to business, real estate and finance. It is on AM830 daily between 2 and 3 in the afternoon.